RBI: Base Rate to be Linked with MCLR

The Reserve Bank of India announced that it would order banks to synchronise the movement of their Base Rates with the MCLR (Marginal Cost of Fund based Lending Rates) in order to ensure that the existing borrowers do not lose out on the benefits of lower interest.

• This linking of the Base Rate with the MCLR will start from 1st April 2018 i.e. from the new financial year.
• The Marginal Cost of Funds based Lending Rates (MCLR) system was introduced on April 1, 2016, to tackle the problems of the Base Rate Regime.
• With the introduction of the MCLR system, it was expected that the existing Base Rate linked loans and other credit exposures would also migrate to MCLR system.
• The 1-year MCLR for most commercial banks as of January 2018 ranges between 7.95 percent and 9.75 percent.
• The RBI announced that since MCLR is more sensitive to policy rate signals, it has been decided to harmonise the methodology of determining benchmark rates by linking the Base Rate to the MCLR with effect from 1 April 2018.
• This step has been undertaken so that the responsiveness of the credit portfolio to monetary policy signals is not hindered by the interest rate on the large part of bank portfolio is linked to base rate.
• The MCLR was introduced, under the leadership of former RBI governor Raghuram Rajan so as to calculate the benchmark lending rate in such a way that it ensures banks pass on policy rate cut benefits to borrowers in a quicker and more transparent manner.
• Under the MCLR, RBI asked all banks to follow the marginal cost of funds method to arrive at their benchmark lending rate.

What is MCLR?

The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. It is an internal benchmark or reference rate for the bank. It was introduced by the Reserve Bank of India with effect from April 1, 2016. It replaced the base rate system introduced in July 2010. 

Aim of MCLR

• To improve the transmission of policy rates into the lending rates of banks.
• To bring transparency in the methodology followed by banks for determining interest rates on advances.
• To ensure availability of bank credit at interest rates which are fair to borrowers as well as banks.
• To enable banks to become more competitive and enhance their long-run value and contribution to economic growth.

Base rate vs MCLR

Base rate calculation is based on the cost of funds, the minimum rate of return, i.e margin or profit, operating expenses and cost of maintaining cash reserve ratio while the MCLR is based on marginal cost of funds, tenor premium, operating expenses and cost of maintaining cash reserve ratio. The main factor of difference is the calculation of marginal cost under MCLR.
Marginal cost is charged on the basis of following factors-

• Interest rate for various types of deposits
• Borrowings 
• Return on net worth. 

Therefore MCLR is largely determined by marginal cost of funds and especially by deposit rates and repo rates

Expected Questions

1. The Reserve Bank of India has decided to link the Base Rate with the_______ w.e.f. April 2018.

a. MCLR

b. CRR

c. SLR

d. Other than the above

2. Which of the following is not a factor of charging  Marginal Cost Lending Rate?

a. Interest rat

b. Borrowings 

c. Capital Formation

d. Return on net worth

3. In which year was Base Rate system replaced by MCLR?

a. 2008

b. 2010

c. 2011

d. 2009